A golden year

Gold has been one of the best performing asset classes in 2024¹, following its breakout in March. This has been driven by a confluence of factors including, falling interest rate expectations and central bank purchases.

Surprisingly, Gold’s stellar performance has not been followed by investor flows. Recent inflows over the past few months have done little to stem a loss of $3 billion from global gold ETFs year-to-date. This is an extension of a wider trend that has existed since 2022, with total ETF flows in Gold consistently falling. Why is this, and what needs to happen for the trend to change?

Outflows driven by increased competition from new alternatives

The driving factors behind the consistent outflows in Gold ETFs over the past couple of years can be attributed to rising interest rates, the technology and AI stock boom, and increased competition within the alternative asset class sector.

As central banks increased interest rates to combat inflation, the opportunity cost of holding non-interest-bearing assets like gold rose. Investors were drawn to higher-yielding bonds and other fixed-income securities, leading to a decline in demand for gold ETFs.

Likewise, the incredible technology and AI boom that has taken place in the post-pandemic recovery has made riskier assets like stocks more attractive to investors. Gold, often perceived as a safe-haven asset during economic downturns, has thus become less appealing.

It is also important to remember that the majority of investors use gold as a diversifier as part of a wider, more balanced portfolio of stocks and bonds. The rise of other alternative investments, such as cryptocurrencies and digital assets, has also contributed to the decline in gold’s popularity. These assets offer diversification benefits and the potential for high returns, making them attractive to investors seeking alternatives to traditional alternative investments like gold.

Paper planes, golden handles

The gold market is primarily driven by paper contracts, such as futures, options, and exchange-traded funds (ETFs). These financial instruments represent the right to buy or sell physical gold at a future date, but they are not the physical metal itself. In fact, only a small fraction of daily turnover of gold is physical bullion. This means that the gold price is largely influenced by factors unrelated to the supply and demand of physical metal. Instead, it is driven by macroeconomic factors and the trading patterns of large quantitative funds. Quantitative funds, which use algorithmic trading strategies to execute large-scale trades, have played a significant role in detaching the price of physical gold from demand.

It appears that Gold’s sharp rise in price from $2150 to $2500 per ounce has been driven by purchases of gold futures by trend following quantitative strategies. These strategies can create momentum effects, where a small price movement can be amplified by a large number of automated trades. They also follow similar trading strategies, leading to herding behaviour. This can create self-fulfilling prophecies, where a rising price leads to more buying by quantitative funds, further driving up the price.

A golden opportunity

Given that gold’s recent price surge seems primarily driven by factors like strong Chinese demand, increased central bank purchases, and the trend-following strategies of large quantitative funds rather than significant ETF inflows, a more substantial price breakout could occur once ETF flows consistently turn positive. This event, when it happens, is likely to be swift and presents a rare opportunity that has not been seen in over fifty years.

¹Past performance is no guarantee of future performance.

The value of active minds: independent thinking

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